FINE PRINT IN GAINS TAX EXCLUSION - By Jay Romano
(reprinted from the 01/22/98 issue of the New York Times)
LAST year, the Federal Government gave an
extraordinary gift to most homeowners by excluding
from taxation as much as $500,000 in gain on the sale of
a principal residence.
But that does not mean that everyone who sells a home at
a profit will get a half-million dollar tax-free ride. In fact,
tax experts say, factors such as marital status, the date of
the sale, the present or former use of the property and
even the state where the property is located (New Jersey
taxes such gains) could have an impact on the tax that
sellers will ultimately pay - or not pay - when selling their
"While most homeowners will benefit front the new tax
law, many may still find themselves in a taxable situation
when they sell their home, ' said Abe Kleiman, a
Manhattan certified public accountant.
The most significant limiting factor of the new law Mr.
Kleiman said, has to do with the marital status of the
owners. Generally, he said, married couples who file
jointly can exclude up to $500,000 in gain from taxable
income - even if the home is in the name of only one of
the individuals. Single taxpayers, Mr. Kleiman said, are
allowed to exclude up to $250,000 in gain. Married
taxpayers who file individually - in order, for example, to
have the ability to deduct medical expenses incurred by a
spouse with a minimal
income - are also allowed exclusions of $250,000 each,
said Mr. Kleiman. One limitation of the new law, he
said, is that it eliminates a rather generous element of the
The two-year rollover provision is gone," Mr. Kleiman
said, referring to a portion of the old law that allowed
sellers to defer paying capital gains taxes on the sale of a
principal residence if they invested the proceeds in a
replacement dwelling of equal or greater value within
Under the new law, however, any gain in excess of the
applicable exclusion may be Subject to tax.
"It's probably not so difficult to imagine older people
who have a home worth $700,000 or $800,000 today, to
have a cost basis of $50,000 or $100,000 if they bought
their first home 40 years ago," he said. In such situations
he added, couples will likely find that they are subject to
taxation on any gain that exceeds $500,000 - or worse -
$250,000 if the seller is an individual.
Moreover, he said, in situations where one spouse dies,
and the surviving spouse has been the sole owner of the
property, he or she would have to sell the property in the
year the spouse died to qualify for the full $500,000
exclusion. Mr. Kleiman said the reason for this is that a
joint return can only be filed for a year that both spouses
Timing is important.
Joel E. Miller, a Queens tax lawyer, said that for a seller
to be eligible for the maximum exclusion under the new
law, the property must have been sold after May 6, 1997,
and must have been owned and occupied as a principal
residence for at least two of the five years preceding the
However, Mr. Miller said, taxpayers who sold their home
after May 6, but on or before Aug. 5, 1997 - as well as
those who sold homes after Aug. 5 under a contract that
was binding on that date - can elect to take the exclusion
provided under the new law or to roll over their gain into
a replacement dwelling within two years of the date of
Mr. Miller cautioned, however, that homeowners in such
a situation should carefully consider the long-term impact
of choosing to roll over their gain.
For example, Mr. Miller said, a married couple with a
$100,000 cost basis in a home they sold during the
"window period" for $700,000 would have a gain of
$600,000 - leaving $100,000 subject to taxation after the
$500,000 exclusion. If the couple elects to "roll over" the
gain into a $700,000 replacement dwelling, the tax on the
gain is deferred until the replacement dwelling is sold.
If the replacement dwelling is sold for $800,000, the
couple will then be subject to taxation on $200,000 of
their $700,000 gain after taking their $500,000
exclusion. On the other hand, Mr. Miller said, if the
couple had chosen not to roll over their gain into a
replacement dwelling, but instead bit the bullet and paid
the tax on the original $100,000 profit, they would have
to pay no additional tax on the sale of the replacement
dwelling because they would get a new $500,000
exclusion on that sale.
Another factor that may limit a seller's total tax savings
has to do with location of the property. While New York
and Connecticut generally follow the same capital gains
tax rules as the Federal Government, New Jersey, for one
state, does not.
According to Dan Emmer, a spokesman for the New
Jersey Division of Taxation, property owners who sell
their New Jersey residences at a profit have to include
their total gain in their New Jersey taxable income, even
if is excluded for Federal tax purposes. Mr. Emmer said
that he was not aware of any pending or proposed
legislation that would change that rule.
He noted that the homeowner can still defer taxes by
rolling over the profit into a replacement within two
Finally, even the use of a property - both present and
former - can have an impact on the tax that may be due
Martin Shenkman, a Teaneck, N.J., tax lawyer, said that
those who use a portion of their home for business
purposes - such as a home office or rental property - must
pay tax on the gain attributable to the portion of the home
used for business.
For example, Mr Shenkman said, if half of a two-family
house is rented out, only the half used as a personal
residence is eligible for the capital gains-tax exclusion;
the rental portion is not. Accordingly, he said a
homeowner with a $100,000 basis in such a house who
then sells the house for $300,000 would have to pay tax
on $100,000 of the $200,000 gain. The same general
result would occur - but in appropriately different
proportions - if part of the home is used as a home office.
One common way to avoid such a result, Mr. Shenkman
said, is to discontinue the business use for at least two
years prior to the sale, thereby making it possible to treat
the entire house as a principal residence. In such a
situation, he said, the seller must still account for any
depreciation deductions "allowed or allowable" on the
business portion of the home.
That means that any depreciation deduction that should
have been taken for the business use of the property -
whether a deduction was actually taken or not - must be
used to reduce the cost basis of the property, thereby
increasing the gain subject to taxation.
Under the new law, Mr. Shenkman said, depreciation
deductions taken before May 7, 1997, are treated as
before - as reductions to the basis that increases gain. The
increase in gain, however, can be offset by the exclusion
available under the new law.
But depreciation deductions taken from May 7 onward
cannot be offset by the exclusion, but must be included
in taxable income. That means, Mr. Shenkman said, that
anyone taking a home-office deduction after May 7
should discuss the matter with his or her tax adviser.
In fact, he said, as generous as the new law seems, it
should not lull homeowners into a false sense of security.
There is no guarantee, he said, that the
$250,000/$500,000 exclusion, which seems like a lot of
money now, will be sufficient to cover accrued gains
realized 20 or 30 years in the future.
"Every homeowner still has to keep detailed records and
crunch the numbers when it comes time to sell," he said.